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Fed could soon stop trimming $4.1 trillion portfolio, Powell says

SAN FRANCISCO/ NEW YORK (Reuters) - The Federal Reserve may wind down its gradual asset-shedding operation sooner than thought, leaving the U.S. central bank with a bigger balance sheet than earlier anticipated, Fed Chairman Jerome Powell said Wednesday.

Powell said no decision had been made on how big the Fed's balance sheet, now down to $4.1 trillion (£3.1 trillion) from a peak of $4.5 trillion, would need to be. Indeed, the Fed has never said exactly how far it plans to shrink the balance sheet, though in the past Fed officials had suggested it would be to less than $3 trillion.

Now though, it looks like it may not get that small.

"The committee is now evaluating the appropriate timing for end of the balance sheet run-off," and will finalise its plan to do so "at coming meetings," Powell said at a press conference following the U.S. central bank's January meeting. "The implication is that the normalization of the size of portfolio will be completed sooner and with a larger balance sheet than in previous estimates."

Powell made clear that the change in policy is unrelated to the state of the economy but is a response to how the financial system has evolved since the financial crisis.

Banks, he said, are stashing much more in cash reserves at the Fed than they did before the crisis, in part to satisfy liquidity and other regulatory requirements put in place since the crisis to make banks safer.

That is a good thing, Powell said. But unless the Fed's balance sheet is also much bigger than it was before the crisis, the increased demand could interfere with the Fed's ability to control its policy lever.

So, Powell said on Wednesday, the Fed will aim for a balance sheet that is big enough to accommodate banks' demand for reserves, plus an unspecified "buffer."

As recently as last June, Powell told Congress he expected normalization of the Fed's balance sheet would likely take three or four years.

The Fed next meets in March, and has further meetings scheduled for late April and mid-June.

"The groundwork is now explicitly laid for a 2019 taper, and possibly cessation of run-off by the end of the year," said Jon Hill, vice president of the U.S. rates strategy team at BMO Capital Market.

STOP THE 50 B'S?

The Fed built up its balance sheet in the aftermath of the 2007-2009 financial crisis, buying trillions of dollars of bonds in an effort to push down longer-run borrowing costs because it had already slashed short-term borrowing costs to near zero.

It began retreating from crisis-era policy in 2015 first by raising interest rates and then in October 2017 by allowing its balance sheet to slowly shrink by no longer replacing all maturing bonds with an equal amount of new bonds. The monthly runoff was capped at $50 billion to minimize any impact on financial markets.

But late last year, prominent investors took to blaming the Fed's balance sheet runoff for market volatility.

President Donald Trump took up the drumbeat against the programme in December, tweeting at the Fed to "stop with the 50 B's" - a reference to the $50 billion monthly cap.

More recently, economists have begun to pencil in bigger balance sheets as well, with JP Morgan's chief U.S. economist this week predicting the Fed would end up with a $3.5 trillion balance sheet.

Powell made clear that any decision on the balance sheet was tied to market plumbing and bank requirements, and was not a referendum on the state of the economy. Still, he did not rule out any future adjustments to the balance sheet, including to offset economic threats.

"We will not hesitate to make changes in light of economic and financial developments," he said. "This does not mean we would use the balance sheet as an active tool, but occasional changes could be warranted."

(Additional reporting by Trevor Hunnicutt in New York; Editing by James Dalgleish)